What Does This Mean

Comments(5)

• 
  DaveT20th December, 2003

  Are there more numbers in the ad? If this is all, then let's do some arithmetic.
  
  Market rents at $40,200 means that at 100% occupancy your rents will generate $40,200 per year in gross rental income. An 8.71 gross rent multiplier, means that the listed price is 8.71 times the gross rents or $350,142.
  
  An 8.05% cap rate means that your annual net operating income is 8.05% of the list price, or $28,186. If you want a debt coverage ratio of 1.25 or better, then your annual debt service can not exceed $22,548. This debt service means that your commercial 15 year mortgage loan at 5% (prime plus one) can not exceed $237,600.
  
  If your lender requires 20% down, then the most you can offer to pay for this property is $297,000 -- quite a bit less than the assumed asking price. I have no idea how the ad projects a 13.72% ROI unless the seller will finance the deal with minimum down payment. Perhaps a 30 year amortization calculation was used to calculate debt service.

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  BMan20th December, 2003

  Thanks,It is starting to make a little sense yes the asking price is 350K. It was probably figured on a 30 yr note and probably with 20% down... not sure because the numbers are all greek. What and how is the 13.....number figured and what does it mean....and is this something that would bring in a positive cash flow? I am sure it is a retail price.....Apprecite the help
  Brian

• 
  DaveT21st December, 2003

  If you pay the $350K list price and make a 20% downpayment, then your initial investment in this property is $70K.
  
  For your $70K investment to yield 13.72%, you would have to receive an annual cash flow of $9604 (about $800 per month). Using the net operating income number from our earlier calculation, this is certainly a possible cash flow but only if your $280K mortgage loan is amortized over 30 years.
  
  If, instead you can only get a 15 year commercial loan, then your annual debt service takes another $8533 out of your cash flow. In this case, your Return On Investment (ROI) -- your yield -- drops to 1.53% (about $90 per month). You can do a little better in an ING money market account yielding 2%.

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  BMan21st December, 2003

  Ok thanks....a ROI does not take into account things like tax break from interest paid on the loan.... or the principal put down (what little there would be) just simply the amount of cash back in pocket compared to the amount taken out of pocket initially.....So this is obviously not a Big time money..... maker....as far as interest... what is a Average % most would want compared to a good %
  
  Thanks

• 
  DaveT21st December, 2003

  ROI calculations are based on the amount invested and the PRE-TAX annual income that investment generates. In the case of investment rental property, your mortgage interest is already deducted from your rental income, along with your other operating expenses.
  
  Your income from investment rental property is your cash flow. In a sense, you DO get a tax break from the mortgage interest paid because the mortgage interest reduces (dollar for dollar) your taxable rental income.
  
  Because the principal component of the mortgage payment comes out of my net operating income, it does reduce my cash flow. I do not deduct the principal component of the mortgage payment from my debt service when I make yield calculations. Income taxes are another story, in that repayment of principal is not an allowed expense when determining my taxable rental income.
  
  ROI also ignores depreciation expense deductions. Often a positive cash flow, that would otherwise be taxable, becomes a passive loss after the depreciation expense. I do not add this tax savings back into my net income either.
  
  I don't have a specific ROI target. The idea behind the ROI calculation is to compare how well my money works for me when I have a choice between investment vehicles. If the ROI for one investment is 1.5% then I might choose another investment vehicle yielding 2%, if these were the only two choices available to me at the time. Of course, I always have a third choice -- do nothing, leave my cash idle until better choices come along.[ Edited by DaveT on Date 12/21/2003 ]